Do Efficient Firms Make Better Acquisitions?

Abstract

Corporate control theory suggests mergers and acquisitions protect shareholder value by allowing good managers to take control of the assets of bad managers. It therefore predicts (1) the acquisitions of poorly-managed targets by well-managed bidders will create more value than other acquisitions, and (2) the target CEO is more likely to be replaced when well-managed firms acquire poorly-managed firms. We examine these predictions. We measure how well a firm is managed using frontier efficiency analysis – the method compares the output of each firm to that of a hypothetical best-performing firm with the same inputs and characteristics as the original firm. We find: (1) the market reacts more positively to acquisitions of efficient firms. (2) Acquisitions by efficient firms are more likely to be all-cash deals and less likely to be all-equity deals. (3) The wealth gains to both the target and the acquirer improve as the efficiency difference between the acquirer and the target increases. (4) The target CEO is less likely to be retained by the merged firm when the efficiency difference increases. (5) The market reacts more negatively to target CEO retention when the target is less efficient than the acquirer.